Sept. 18 (Bloomberg) -- Morgan Stanley is losing hedge-fund clients who are concerned that a record drop in the New York- based investment bank's stock threatens its finances, investors and industry executives said.

Hedge funds that account for less than 10 percent of Morgan Stanley's prime-brokerage balances this week withdrew their money or told the firm they planned to, according to a person with direct knowledge of the matter. The loss of all hedge-fund accounts wouldn't materially affect the company's access to reserves, said the person, who asked not to be identified because the information is confidential.

Deutsche Bank AG, Citigroup Inc., Credit Suisse Group AG and JPMorgan Chase & Co. are picking up Morgan Stanley's clients after Lehman Brothers Holdings Inc. went bankrupt earlier this week. Lehman won't return ``billions'' of frozen prime-brokerage assets ``in the short term,'' said PricewaterhouseCoopers, administrator for the Lehman bankruptcy. Morgan Stanley has declined about 52 percent in New York trading since Sept. 12.

``Hedge funds tend to look at counterparty risk as they would an equity investment,'' said Adam Sussman, director of research at TABB Group LLC, a New York-based adviser to financial-services companies. ``If they'd bet against the stock, they'd also be likely to minimize their exposure to their prime brokerage and trading over-the-counter derivatives with them.''

CIC Stake

The client defections came before the New York Times reported that Morgan Stanley is weighing a merger with Wachovia Corp. or several other banks. Morgan Stanley may sell a larger stake to China Investment Corp., according to a person familiar with the matter. CIC bought a 9.9 percent stake in December.

Prime brokers provide hedge funds and other clients with services such as stock lending and clearing trades. Morgan Stanley's prime-brokerage assets are a minimal amount of the bank's $180 billion of liquidity, said Mark Lake, a Morgan Stanley spokesman.

``Despite the recent market volatility, we are confident that Morgan Stanley will maintain an industry-leading prime- brokerage franchise,'' he said.

Morgan Stanley said yesterday that its prime brokerage reported record results during its third quarter. The bank and Goldman Sachs Group Inc. are the biggest prime brokers, according to a Tabb Group report in May.

Officials for Frankfurt-based Deutsche Bank, JPMorgan in New York, Zurich-based Credit Suisse and Citigroup in New York declined to comment.

Rise in Revenue

Global banks' prime brokerages may generate about $11.5 billion in revenue from hedge funds this year, up 15 percent from 2006, Tabb Group said.

GLG Partners Inc., the London-based hedge fund that oversees $24 billion, said Sept. 16 that some ``residual'' trades with Lehman didn't clear before it filed for bankruptcy. GLG said it had used Lehman as one of its prime brokers.

Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested.

BNP Paribas SA's global head of hedge-fund relationships, Talbot Stark, said the Paris-based bank had got a ``flood'' of clients for its prime brokerage since Lehman filed for bankruptcy.

``Foremost on people's minds is ensuring that wherever they decide to put assets, they will be secure,'' he said in an interview today.

To contact the reporters on this story: Saijel Kishan in New York at skishan@bloomberg.net; Katherine Burton in New York at kburton@bloomberg.net;

Last Updated: September 18, 2008 11:48 EDT